When and how do I file and pay taxes as a sole proprietor?
Most sole proprietors need to file income tax returns and pay taxes on their business income. Under IRS rules, you are required to file an income tax return if your net earnings from your business totaled $400 or more. Note that even if your self-employment earnings were less than $400, you might still have a tax filing obligation or be eligible for a refund. Additionally, as is the case with other types of business entities, sole proprietors are subject to self-employment taxes.
As a sole proprietor, instead of filing a separate tax return for your business, you report your business income on IRS Form 1040, using Schedule C to report your business profit or loss. According to the IRS, Schedule C is required when the primary purpose of your business is income or profit, and you are regularly involved in the activity. Be prepared to use Schedule C to report your accounting method, gross receipts, sales, income, cost of goods sold, and deductible business expenses. If you operate more than one business as a sole proprietor (e.g., you have two separate side businesses), you will need to complete a separate Schedule C for each business.
Depending on the nature of your business, you may need to file additional tax schedules with your return. In such cases, you can gain valuable peace of mind when you have a tax pro file for you, rather than trying to determine which schedules are required, calculating your tax obligations, completing forms and schedules, and filing your own tax returns.
Can I write off expenses as a sole proprietor?
Yes, as a sole proprietor, you can write off certain business-related expenses, potentially lowering the amount you owe in taxes. To be deductible under IRS rules, an expense must be considered both ordinary and necessary. An expense is ordinary when it is common in your industry. A necessary expense is one that is both helpful and appropriate for your sole proprietorship.
Some of the most popular sole proprietorship tax deductions include the following:
- One-half of the self-employment taxes paid (the employer portion).
- Sales taxes.
- Business licenses.
- Health insurance premiums (unless you are eligible to participate in an employer-sponsored plan).
- Business use of a vehicle (consult your tax professional to determine the most favorable methods for calculating your deduction).
- Home office deduction (if you use part of your home regularly and exclusively for your sole proprietor business, and it is your principal place of business).
- Qualified business income tax deduction of 20% (if your business qualifies).
- Internet and phone expenses (the portion attributable to your business).
- Business-related meals (subject to certain limitations).
- Qualified business travel expenses.
- Interest on business loans.
- Subscription costs for specialized publications.
- Education costs (if the course or training is related to your sole proprietorship).
- Business insurance expenses.
- Rent for office, warehouse, or retail space for your business.
- Certain startup expenses.
- Advertising and marketing costs.
- Self-employed retirement plan contributions.
- Software expenses.
- Wages to employees and payments to independent contractors.
- Legal and professional services.
The deductions listed above are the most common types of business-related expenses claimed by sole proprietors, but there are others. A tax attorney or other tax professional can help you evaluate which deductions your sole proprietorship may be eligible to claim to lower your tax obligation.
It is important to keep accurate records of your income and expenses in case your business is audited by the IRS. Digital records are generally sufficient for an IRS audit, and the IRS increasingly allows paperless responses to IRS correspondence.
What are the tax advantages of a sole proprietorship?
There are several reasons entrepreneurs may choose a sole proprietorship over other types of business entities. From a tax standpoint, one of the biggest benefits is streamlined filing compared to corporate business entities.
First, while corporations, LLCs, and partnerships need their own tax ID numbers (also referred to as an Employer Identification Number, or EIN), sole proprietorships can opt to use the sole proprietor’s Social Security Number for tax purposes. A sole proprietorship’s income and expenses are reported on the individual’s tax return, eliminating the need to file a separate tax return for the business entity. So, while the federal tax rate for corporate income is 21% for 2024, the sole proprietorship tax rate is effectively your own individual income tax rate, which may be lower. Additionally, some sole proprietorships may qualify for a 20% deduction on net business income, as provided under the Tax Cuts and Jobs Act of 2017.
Figuring out business taxes, tax rates, deductions, and credits can be complex. To claim deductions, credits, or most tax relief or incentives, you typically are required to qualify for and request them. Your tax professional can help you claim the tax write-offs that are available to your business.
Can sole proprietors get tax refunds?
Regardless of whether your business is structured as a sole proprietorship, corporation, or other type of entity, you are entitled to a tax refund if you pay more during the tax year than you actually owe. Your estimated quarterly tax payments are based on your income from the previous tax year. If you overpaid throughout the year in your estimated tax payments, you can claim a refund when filing your tax return.
Many sole proprietors also have “day jobs” with W-2 income and tax withholding. If the total amount you pay during the year through tax withholding and your quarterly estimated tax payments for your business is less than the amount due, you will owe taxes when you file your return (including possible penalties for underpayment). However, if your tax withholding from your W-2 job plus your estimated tax payments exceed the amount you owed, you may qualify for a tax refund.
What are my options if I am not able to file my taxes on time?
Filing tax returns on time and paying what you owe in full by the payment deadline is important. If you file your tax return after the deadline, you may be subject to hefty penalties and interest charges on unpaid taxes.
Sometimes, sole proprietors and other small business owners struggle to file their tax returns on time because it is a busy time of year for their business or there are issues with the documentation needed to prepare their returns. To help with this, the IRS offers an option to request an automatic extension of time to file tax returns by using Form 4868. This approach gives you an additional six months to file your return and tax schedules, effectively changing the filing deadline to October 15th.
However, an extension of time to file does not mean you have an extension of time to pay your taxes. If you request an extension, you may want to estimate the amount of taxes you owe and pay what you can by the original deadline (April 15, 2025, for the 2024 tax year). Penalties and interest will accrue until you have paid your taxes in full, so the sooner you can pay, the better.
The reality for most sole proprietors is that taxes on their business income are an unwelcome but necessary part of doing business. Because of the potential for penalties and interest to accrue when mistakes are made with business taxes, there is little room for error.
If you still have questions about how to file taxes as a sole proprietor, reach out to a Rocket Legal Pro for affordable legal advice. If you need tax help, get matched with a tax pro via Rocket Tax™ to save time and money filling your tax returns.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.
